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New Form 990 Aims for Transparency, Accountability, and Oversight

While
transparency, accountability, and oversight do not appear to be
tax issues per se, recent legislative focus and IRS
enforcement in this area have heightened the need for tighter
controls within the nonprofit sector. The IRS increased the number
of audits in 2006 by 40% in the exempt area and will continue to
expend resources with a specific focus on management practices and
internal controls.

Both the Tax Increase Prevention and
Reconciliation Act of 2005 and the Pension Protection Act of 2006
(PPA ’06) have had a significant impact in the nonprofit sector.
Additional disclosures on investment activities, such as foreign
activities and participation in alternative investments, provide
greater insight into the investment activities of nonprofits. In
addition, many of the provisions of PPA ’06, such as the public
disclosure requirement of an organization’s unrelated business
income tax return (Form 990-T, Exempt Organization Business Income
Tax Return) and the more stringent rules governing donor-advised
funds and supporting organizations, have created additional
complexities in the nonprofit sector.

Much of the overall
tone heard in the nonprofit sector resonates from the
Sarbanes-Oxley Act of 2004. While many state attorneys general
introduced legislation in this area, the U.S. Senate Finance
Committee has taken the lead with federal legislation aimed at the
nonprofit sector. The Finance Committee also has encouraged the
IRS to increase enforcement and Treasury to provide additional
guidance.

In May 2007, in a letter to the Treasury Secretary,
Senators Charles Grassley (R-IA) and Max Baucus (D-MT) proposed
continued efforts to provide even greater transparency in
nonprofit reporting (www.finance.senate.gov/press/Bpress/2007press/prb052907.pdf).
Legislators are concerned that the current Form 990, Return of
Organization Exempt from Income Tax, is not adequate to encompass
vital information regarding parts of the nonprofit sector. The IRS
and government officials are placing emphasis on large, complex
institutions such as hospitals and universities, stating that the
current Form 990 may require more detailed questions to provide
transparency and accountability.

Both the 2005 and 2006
Forms 990 had significant revisions, but the completely redesigned
Form 990, released on June 14, 2007, for public comment, listed
transparency as the first of its three guiding principles. The
second is the promotion of compliance, and the third is to
minimize organizations’ burden of preparing the form. The new Form
990 is available on the IRS website (www.irs.gov), and the public comment period is
open until September 14, 2007.

The revisions to the form
are noteworthy, not only because of the potential for triggering
IRS scrutiny, but also because of the form’s public nature. It is
a 10-page core form that must be filled out by all organizations
with a Form 990 filing requirement. Fifteen schedules supplement
the core form; they are not applicable for all organizations but
are required based on an organization’s entity type or its
participation in certain activities.

While the form changes
are not expected to be effective until tax year 2008, it is not
too early for practitioners to familiarize themselves with the new
form and and to educate their clients about the changes that are
taking place in the nonprofit sector. Highlighted below are some
key areas that have been identified as needing greater reporting
and significant updating.

Executive Compensation

In determining the reasonableness of compensation or other
transactions with disqualified persons (i.e., those individuals
with significant influence over the affairs of an organization),
the federal regulations provide that comparison data should be
maintained by the organization. Examples include (1) compensation
paid for comparable positions, (2) the availability of similar
services in the geographic area, and (3) independent compensation
surveys.

Users of Form 990 contend that there are
instances when executives for charities receive compensation from
various sources. In such cases, these payments may be creatively
disguised on the tax form based on the number of places the same
information is reported on the current forms. Because many
executives of charitable organizations receive compensation in the
form of housing, travel, deferred compensation, etc., legislators
have recommended that the forms be redesigned to clearly
distinguish the various financial arrangements treated as
compensation to individuals.

Tax advisers working with
charitable organizations should educate board members and
organization officials on the need for comparison data. Emphasis
should be placed on the importance of oversight and on officials’
responsibilities when reviewing and approving reasonable
compensation packages and excess benefit transactions for
executives.

Related Organizations/Joint Ventures

Because many nonprofit organizations are related to both
for-profit and nonprofit organizations through common ownership
and are also engaged in joint ventures, legislators believe that
the public should be able to see the relationships among
organizations. Concerns exist in particular with the potential for
charitable assets being used for private benefit.

Much of
the focus of legislators and the IRS is being placed on hospitals
and universities. As the health-care industry continues to evolve
at record speed, physicians and hospitals have begun to consider
an increased number of options for forming joint ventures to
provide various ancillary services, such as equipment-leasing
ventures, diagnostic services, etc. Rev. Rul. 98-15 was released
to help resolve tax questions about joint ventures between
nonprofit tax-exempt organizations and taxable for-profit
corporations. It allows exempt hospitals the flexibility to
partner with other organizations or corporations. However, it does
require that charitable purposes supersede profit motives. It is
important that exempt organizations entering into such
partnerships ensure that the partnership furthers charitable
purposes and does not result in greater than incidental private
benefit to the taxable partner or other private parties.

Redesigned Form 990’s goal will be to highlight the
relationships between for-profit and nonprofit organizations to
accurately reflect the organizations’ operations so the IRS can
effectively assess the risk of noncompliance.

Charity
Care/Community Benefits

Nonprofits, and hospitals in
particular, have been under increased scrutiny as the government,
legislators, and the public have become concerned about holding
the organizations accountable to their communities for their
tax-exempt benefits. The definition of “community benefit” that
policy makers use as a basis for answering this question could
influence their decisions about whether the nonprofit
organizations are meeting their obligations to retain tax
exemption.

The following are some attributes that a task
force from the Healthcare Financial Management Association
selected as relevant to explaining why a nonprofit organization
warrants tax-exempt status. (Although relevant to tax-exempt
status, any one of these attributes alone is probably not
sufficient to warrant tax exemption.)

Mission: The organization should clearly articulate its
charitable purpose and regularly demonstrate that its mission is
fulfilled.

Use of financial surpluses: All financial
surpluses are used exclusively to further the organization’s
charitable purpose, and no individual receives any portion of the
surplus, except as fair compensation.

Accountability: The organization is
accountable to the public through a board that is committed to the
needs of the community or service area.

Charity service: There is no denial of
essential services (such as emergency services) to residents of
the service area based on the inability of a person to pay for
those services.

Reduced government burden: The organization
provides services that are needed and that would otherwise have to
be provided by the government.

As the bar has been raised,
recent events suggest that the movement toward providing
transparency, accountability, and oversight for nonprofit
organizations will be implemented in revisions to Form 990. The
new reporting requirements will aim to provide the public with a
realistic picture of charitable organizations and to demonstrate
how they are carrying out their missions. Nonprofit organizations
should be advised to make a strong effort to play an active role
in this policy debate to preserve their exempt status and build
trust among their supporters.

EditorsNotes

Frank J. O'Connell, Jr., CPA, Esq, Crowe Chizek, Oak Brook,
IL.

Unless otherwise noted, contributors are independent members
of Crowe Chizek.

If you would like additional
information about these items, contact Mr. O’Connell at (630)
574-1619 or foconnell@crowechizek.com.

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